The Stochastic Oscillator measures the speed or momentum of price movements. It is used to identify bullish and bearish reversals. And since it is range bound it can also identify oversold and overbought levels.
The Stochastic Oscillator consists of:
%K Line (Blue Line)
%D Line (Red Line)
The 2 types of Stochastic Oscillators are:
Fast Stochastic (FSTO)
Slow Stochastic (SSTO)
Ways to Interpret the Stochastic Oscillator
Interpretation of the Stochastic Oscillator
Buy
When the %K Line (Blue Line) crosses the %D Line (Red Line) upwards.
Buy
When both the %K Line (Blue Line) and the %D Line (Red Line) are below 20.
Sell
When the %K Line (Blue Line) crosses the %D Line (Red Line) downwards.
Sell
When both the %K Line (Blue Line) and the %D Line (Red Line) are above 80.
Look for the Following Instances
Identify the Following Shapes
Identify a Bottom Forming
When the Slow Stochastic Oscillator (SSTO) forms a basin.
Identify a Top Forming
When the Slow Stochastic Oscillator (SSTO) forms an umbrella.
Look for the Following Divergences
Divergences
Identify a Bottom Forming
When the price of the stock goes lower but the Stochastic Oscillator goes higher.
Identify a Top Forming
When the price of the stock goes higher but the Stochastic Oscillator goes lower.
Example 1
Source: Thinkorswim by TDAmeritrade
Example 2
Source: Thinkorswim by TDAmeritrade
Example 3
Source: Thinkorswim by TDAmeritrade by TDAmeritrade
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